Key Takeaways
- Cash flow available to equity holders after debt costs.
- Includes operating cash minus taxes, reinvestments, and debt payments.
- Used for equity valuation, reflecting capital structure impact.
What is Levered Free Cash Flow (LFCF)?
Levered Free Cash Flow (LFCF) is the cash flow available to equity holders after accounting for operating expenses, taxes, reinvestments, and all debt-related payments such as interest and principal repayments. It reflects the true cash a company can distribute to shareholders or reinvest in growth, incorporating the firm's capital structure and financing decisions.
This metric differs from other cash flow measures by explicitly including the impact of leverage, making it crucial for equity valuation and understanding shareholder returns in structures such as a C-Corporation.
Key Characteristics
LFCF has distinct features that differentiate it from unlevered cash flow metrics:
- Equity Focused: Represents cash flow available specifically to shareholders after all debt obligations are met.
- Includes Debt Costs: Accounts for interest payments and principal repayments, unlike unlevered free cash flow.
- Variable Calculation: No single formula; commonly derived from net income, EBITDA, or unlevered free cash flow with debt adjustments.
- Reflects Capital Structure: Sensitive to financing decisions and leverage, essential when using models like the Hamada equation for risk assessment.
- Used in Equity Valuations: Discounted at the cost of equity, making it relevant for investors analyzing companies like Bank of America.
How It Works
LFCF starts with net income or EBITDA and subtracts reinvestments in working capital and capital expenditures, then adjusts for net debt changes including new borrowings and repayments. This approach ensures the cash flow reflects obligations to debt holders before any distributions to equity holders.
For example, calculating LFCF from net income adds back non-cash charges like depreciation, subtracts increases in net working capital and capital expenditures, then adds net borrowing, capturing the full impact of financial leverage. This makes it a practical measure for companies structured as a Designated Activity Company (DAC) or similar entities managing debt carefully.
Examples and Use Cases
Understanding LFCF is vital across industries and specific company analyses:
- Financial Institutions: Firms like JPMorgan Chase use LFCF to gauge cash available to equity after regulatory capital and debt service.
- Banking Sector Insights: Evaluating LFCF among top financial stocks can be enhanced by consulting resources such as best bank stocks to identify companies with strong cash flow management.
- Corporate Valuation: Analysts applying discounted cash flow methods rely on LFCF to value companies with varying debt levels, ensuring accurate shareholder value estimations.
Important Considerations
While LFCF provides a clearer picture of cash available to equity holders, it can fluctuate significantly with debt refinancing and capital expenditure cycles. You should interpret it alongside other metrics like earnings and understand the firm's debt structure.
Additionally, negative LFCF does not always indicate poor performance—it might reflect strategic investments or temporary leverage adjustments. Careful analysis of the components behind LFCF is necessary for sound financial decisions.
Final Words
Levered Free Cash Flow reveals the cash truly available to equity holders after debt obligations, making it essential for equity valuation. To apply this insight, start by calculating LFCF for your target company and compare it against peers to gauge financial flexibility.
Frequently Asked Questions
Levered Free Cash Flow (LFCF) is the cash available to equity holders after covering operating expenses, taxes, reinvestments, capital expenditures, and all debt-related obligations like interest and principal repayments. It shows the leftover cash a company can use for dividends, share buybacks, or reinvestment, reflecting the impact of its capital structure.
LFCF accounts for debt payments by subtracting interest and principal repayments, focusing on cash available to equity holders. In contrast, Unlevered Free Cash Flow (UFCF) measures cash available to all capital providers before debt costs, making UFCF more suitable for enterprise valuations using WACC.
LFCF is important because it shows the actual cash a company can return to equity shareholders after meeting all its financial obligations. It helps investors understand how much cash is truly available for dividends, share repurchases, or growth funded by equity.
LFCF can be calculated starting from net income by adding back depreciation, subtracting changes in working capital and capital expenditures, and adjusting for net borrowing. It can also be derived from EBITDA by subtracting working capital changes, capex, and mandatory debt payments, or from unlevered free cash flow by adjusting for interest, debt repayments, and new debt issuance.
Yes, LFCF can be negative if a company spends more on capital expenditures, working capital, or debt repayments than it generates in cash. Negative LFCF might indicate heavy reinvestment, debt servicing challenges, or cash flow stress, and investors should analyze the reasons carefully.
LFCF is used in equity valuation models where cash flows are discounted at the cost of equity since it reflects cash available to shareholders after debt payments. This contrasts with unlevered free cash flow, which is discounted at the weighted average cost of capital for enterprise valuation.
Net borrowing, which is new debt issued minus debt repayments, affects LFCF by either increasing it if there's a net inflow or decreasing it if more debt is repaid. This adjustment reflects actual cash changes from financing activities relevant to equity holders.
